Part 2

Dogger Bank Wind Farm: An Alternative Evaluation

British politician Michael Smart has recently come across a study conducted by a team of Norwegian researchers. This study estimates a negative net present value for the Dogger Bank Wind Farm. This poses a significant challenge to Mr. Smart's political agenda. Consequently, he has enlisted the services of you, a consultant by the name of Winston Smith, to arrive at an alternative and more favorable conclusion.

The project owners, namely SSE Renewables, Equinor, and Vrgrnn, have projected a capital expenditure (CAPEX) of 9 billion pounds. Distinguished researcher Professor Flyvbjerg from Denmark has found, through empirical research, that 9 out of 10 projects experience cost overruns. On the contrary, the Norwegian researchers have assumed that this project will not exceed its budget. You, however, believe that this project could be an exception and could potentially be completed with a CAPEX of 1 billion pounds under budget. With the project's noble purpose and the motivation it brings, achieving cost savings is plausible.

The Norwegian researchers have assumed that the project will strictly adhere to the schedule. Professor Flyvbjerg's research indicates that few projects actually manage to do so. Nevertheless, you believe that the project's significance could motivate the team to complete it a year ahead of schedule, resulting in the first year of operation commencing in year 6.

Regarding the capacity factor, the Norwegian researchers have assumed it to be 0.55. However, based on GE Electrics' wind turbine generator (WTG) performance, a capacity factor of 0.63 has been observed during a three-month test. Considering the potential benefits of climate change on wind patterns, a capacity factor of 0.70 seems reasonable.

The first 15 years of operation are governed by a fixed price of 47 /MWh due to the contract for difference (CfD). While this parameter is inflexible, the market price for the subsequent 20 years remains uncertain. The Norwegian researchers propose a price of 50 /MWh. You contend that this price could reasonably be set higher, say 75 /MWh, given the circumstances. The wind farm's capacity of 3.6 GW is also locked due to the CfD.

The Norwegian researchers have assumed a decommissioning cost (DECOM) equal to 25% of the CAPEX. However, they have neglected to account for the value of the scrap. In your view, a DECOM cost of just 1% of CAPEX, with a scrap value of 10% of CAPEX, is more accurate.

In terms of the discount rate, the Norwegian researchers use 5.9% for the initial 15 years and 8.5% for the subsequent 20 years. Aligning with the government's 4% discount rate, you opt to use a consistent single discount rate throughout the analysis.

Lastly, considering the operational expenditures (OPEX), the researchers' reported figure appears to be standard. However, after examining past wind farms' performance, the lowest observed OPEX is 80 thousand /MW per year. You believe that this wind farm could achieve performance comparable to the best wind farm in history.

Questions to Address:

1. What is the net present value (NPV) of the Dogger Bank Wind Farm?

2. What is the exact payback period of the project?

3. Create a diagram illustrating the relationship between the project's net present value and the discount rate. Determine the project's discount rate.

4. Calculate the break-even electricity price for this project. In other words, what must the market electricity price be for the net present value to be zero? Keep in mind that the fixed price remains at 47 /MWh during the initial 15 years due to the CfD.

5. You believe there's a 60% chance of Michael Smart winning the election. If he is elected and increases the CfD price from 47 to 55 /MWh, what would be the expected net present value of the project?